Trade Finance Article

Trade finance or international factoring?

30 November,2018 | Tim Nicolle

PrimaDollar is a trade finance company.

This post covers the differences between trade finance and international factoring, and why these differences are important.

Both international factoring and trade finance offer solutions to support the international supply of manufactured goods – like garments, household goods, consumer electronics etc: any merchandise that is generally shipped and sold in shops to retail customers.

Trade finance companies like PrimaDollar are new arrivals on the international scene. We are providing a new generation of trade finance solutions which are cheaper, quicker and simpler than existing options.

1. Comparison

How much is paid for the invoice upfront? (ie, the advance rate)

Trade finance:

Over 90% of the invoice amount, sometimes even 100% is advanced.

Factoring

Usually 80% of the invoice amount.

When is the cash paid?

Trade finance:

Upfront at shipment of goods. Sometimes TT in advance of shipment is possible.

Factoring

Usually after goods are shipped to the buyer and often only after an invoice is approved.

Typical costs

Trade finance

5% to 12% per annum depending upon buyer location, credit quality and the size of the purchase order program.

Factoring

10% to 24% per annum

Fees

Trade finance

PrimaDollar does not charge additional fees

Factoring

A flat % often subject to a minimum US Dollar amount per trade

Finance is committed from:

Trade finance

Pre-shipment, even at PO stage

Factoring

Availability of an invoice that is confirmed by the buyer

Letter of credit facility (LCs)

Trade finance

Included as standard

Factoring

Not available

Handling of chargeback risk

Trade finance

Chargebacks / penalties are accepted up to approval of shipping documents, not accepted afterwards

Factoring

Chargebacks / penalties can be accepted (so the advance rate is lower, and the funding cost is higher)

Availability

Trade Finance

This is a specialist product, not yet widely available

Factoring

Widely available

2. Do these differences matter to suppliers (exporters)?

Yes, these differences matter a great deal.

Most suppliers need help with pre-shipment finance, whilst most buyers would like to work on open account (“sale contract”) and to pay later.

Working on open account means that buyers do not use their banking facilities, avoid the paperwork and hassle of LCs, and can sell the goods before they have to pay for them, resulting in a positive cash flow.

Consequently, there is often a cash flow gap between buyers and suppliers. It can be six months from the date when the supplier starts making the goods (ie, ordering materials, paying wages) and the date when the buyer finally pays.

Both international factoring and trade finance products help to address this cash flow gap.

Some suppliers, for example many based in Europe and the US, have good balance sheets and good access to banking finance. For these suppliers, they may need no assistance, or an international factoring solution can be enough. International factoring will shorten the waiting time for payment and help with supplier’s cash flow.

But there are many suppliers where international factoring is providing too little cash and too late.

Here are some regular situations where international factoring is not a solution, and trade finance (as provided by PrimaDollar) is required:

The supplier needs pre-shipment finance:

  • The supplier needs to borrow from its local bank to purchase materials and pay the wages in order to make the goods.

  • Local banks do not like to lend against purchase orders, unless the buyer is a household name with an excellent payment record. The reason is that purchase orders are easy for buyers to cancel. The local bank will usually ask for a letter of credit to support the purchase order, which the buyer may be unwilling to provide.

  • As a trade finance company, PrimaDollar can provide the letter of credit so that the buyer does not have to. This is a standard feature of the service that trade finance companies offer.

Inventory finance needs to be cleared before shipment:

  • The supplier has various facilities from its local bank which are secured on the stock of goods that it has from time to time (“inventory”).

  • In order to ship, the supplier needs the local bank to release the pledge that it holds over the finished goods. But the local bank will not do this without additional collateral. The reason is that the finished goods are part of the collateral supporting the debt. When the goods go on the ship, control over the goods is diminished (and usually transferred to the buyer): the collateral is now lower than it was – and this can leave the local bank with a shortfall in its protection.

  • The local bank will usually insist on some guarantee of sight payment to be provided to replace the lost collateral, or even that payment should be received in advance of shipment to reduce the finance outstanding.

  • This is where a trade finance solution meets the need. PrimaDollar can arrange a letter of credit or provide an acceptable payment guarantee, and sometimes we will pay “TT in advance” (before the goods are loaded onto the ship).

Foreign exchange regulations mean that the goods cannot clear local customs:

  • In many countries, particularly in South Asia, local banks are required by their central bank to ensure that the foreign exchange proceeds of international trades are received against the shipments that are made. This is part of the control regime imposed to ensure that tax is not avoided and the benefit of exports is duly received and accounted for in the local economy. These are good sense arrangements. In Bangladesh, for example, the local bank is required to ensure that at least 95% of the export value is received in cash; in Pakistan, the level is 93% in cash.

  • The important point is that it is the local bank that has the responsibility to ensure that full payment is received and that “foreign exchange overdues” do not arise. An overdue will arise if the goods are exported but the cash does not arrive. In some countries, this gives rise to a criminal liability (because it is treated as a foreign exchange fraud). Understandably, everyone is nervous.

  • It is quite common to find that the supplier cannot export the goods on open account (“sale contract”) with deferred payment. The local bank simply will not take the risk.

  • This is where a trade finance solution is required. PrimaDollar’s pays cash “at sight” of documents (or even sometimes against copy documents), backed up by a letter of credit, if required. Our cash payment is enough to ensure that the foreign exchange control regulations are met immediately and in full – there is no risk that the regulations will be breached. Both the supplier and the local bank are happy.

The situations described above are very common in emerging markets.

In all these cases, our trade finance solution is provided without needing collateral from the supplier. Our funds settle the existing local bank claims: indeed, often we pay the local bank directly to ensure that the goods are released for shipment on a timely basis.

Our trade finance solutions properly address the needs of suppliers in these locations.

3. Do these differences matter to buyers (importers)?

Yes, these differences matter a great deal.

Buyers understand the importance of efficient supply chains that are properly supported financially.

Moreover, as margins continue to come under pressure, many buyers are moving their supply chains to lower cost locations (for example, in South Asia).  But suppliers in these locations need significantly more financial support as they are often smaller and less well capitalised than those in more developed locations, and they also have to comply with tough foreign exchange controls.

Trade finance, as provided by PrimaDollar, is a significantly better solution for the emerging markets supply chain than alternatives like international factoring.

The reasons are:

  • Cost: Trade finance is a lot cheaper than international factoring. Whilst this cost may be borne by the supplier, all buyers recognise that, in the end, the finance charge ends up in the unit price of the goods that they are sourcing.

  • Reliability: We regularly run into situations where goods are delayed for shipment because suppliers are struggling to release local bank pledges, clear foreign exchange regulations or deal with late-payment issues on other trades. What PrimaDollar offers deals with or avoids these problems. Moreover, working with us is significantly better than suppliers dealing with unofficial local sources of short term cash.

  • Fitness: The trade finance solution, unlike conventional factoring products, is absolutely designed for trade with emerging market suppliers. It meets all the needs of the supplier without causing problems for the buyer (such as accounting issues, increases in risk, use of banking lines etc.).

We have been working with buyers in the following situations:

Goods are blocked in country for lack of an LC:

  • The supplier has made the goods using local bank support and has agreed open account (“sale contract”) terms with its buyer. However, due to a lack of available banking lines and collateral, the local bank has not agreed to release the goods for shipment and a delay has occurred.

  • We are usually able to provide credit within 48 hours – and at the low costs already mentioned. There are no IT changes for the buyer, and its procurement, QA and other arrangements continue as before.

  • Using our facilities with Barclays, provided we are happy with the buyer credit risk, we issue a sight LC with a 95%+ advance rate against the commercial invoice. The local bank is happy to accept this LC and the goods are cleared for shipment. We then, through Barclays, pay the local bank against receipt of the shipping documents.

  • We collect from the buyer later, on the due date of the invoice.

The buyer’s supply chain finance program pays too late:

  • The buyer is a global multi-national with a supply chain finance program in place. Their standard trade terms are 120 days after shipment. Suppliers can call down funds at 45 days after shipment for a 2% discount, provided the goods have arrived and the invoice has been approved. The supplier facilitates this via an online portal.

  • Unfortunately, the local bank is not willing to release the pledge over the goods that protects its pre-shipment inventory financing and it will thus not approve the export. This is because it is the first time that the supplier has worked with this buyer and the supply chain finance comes too late and with too much uncertainty (for example, post-shipment chargebacks could reduce the final cash receipt). Although the buyer is well known, the lack of history in the relationship leaves the local bank uncomfortable.

  • PrimaDollar solves this problem by providing a payment guarantee before shipment which pays the full export value at sight of documents. This meets the foreign exchange regulations, ensures that pre-shipment finance is repaid and leaves PrimaDollar to deal later with collection of the amount due from the buyer. Moreover, our pricing is competitive with the supply chain finance offer – so that both the buyer and the supplier have acceptable economics from the arrangement.

4. PrimaDollar’s trade finance solution

PrimaDollar’s trade finance products offer complete and appropriate solutions at low cost for the emerging market supply chain.

Emerging market suppliers, as we have explained, have different needs to suppliers in developed markets. They have limited access to finance and credit insurance, and they often have to comply with onerous local regulations. This means that specialist trade finance solutions are required, and off-the-shelf factoring solutions (as well as supply chain finance solutions) are often not the answer.

When considering how to finance emerging market supply chains, buyers (importers) and suppliers (exporters) should both look for a trade finance solution.

Trade finance from PrimaDollar: cheaper, quicker, simpler.

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